Monday, January 23, 2017

"Breakouts", "hidden hands", and policy reforms

The demonetisation is a teachable moment for public policy. In particular, it offers insights about the role of "breakout" decisions in paving the path for addressing fundamental challenges.

There are two problems with addressing fundamental economic or social challenges like pervasive informality or poor urban management or a culture of harassment corruption. One, its resolution requires bringing to play several complementary policy levers. The sheer complexity of the challenge generates enormous inertia against any action. In fact, even thinking through and identifying the various reform interventions, sequencing them, and formulating an action plan, can be a massive challenge. Two, at least some of the policy changes are likely to be unpopular or would have to overcome entrenched and powerful vested interests. As we all know, they can be very difficult opponents. This twin challenge of inertia and unpopularity or opposition are most likely behind all such problems.

It is in this context that demonetisation assumes significance. Much has been debated about demonetisation in India, its reasons and intentions, the implementation failings, and its costs and benefits. Reasonable people can have differences about all these. However, it would be far less contentious if I were to claim that it has succeeded in pushing structural issues like pervasive informality, low tax base, and predominance of cash transactions to the top of the agenda, like no other conventional approach could have done in rambunctious democracies like ours. Some measures, though far from adequate, have been initiated in all these areas, and it would not again be contentious to claim that even these would have been unlikely without the demonetisation "breakout".

This is not to elevate demonetisation as an end in itself, but to view it as an instrument to call attention and gain political engagement to the resolution of fundamental problems, which would otherwise have been difficult, even impossible. It is also not to overlook the need to follow-up such "breakouts" with substantive policy action, the absence of which would defeat the very purpose of the "breakout".

If the political leader keeps in mind these concerns and pursues such "breakouts", then they present a politically expedient and practical strategy to initiate reforms on complex structural issues. The breakouts can provide the rallying platform, overcome opposition, and help generate the momentum to carry through the tough and unpopular reforms. Further, once the trigger is pulled, and we have to live with it, new opportunities and possibilities, that were either invisible or considered long-shots, suddenly appear on the horizon, for whatever reasons. So disruptive "breakouts" may be a prudent strategy to take on deep structural reforms.

Consider the issue of administrative reforms and lateral entry. Any exploration of this would open up several threads of uncertainty. How do you ensure that the quality of entrants is ensured? How do we ensure that the revolving door approach does not worsen corruption? How do we align incentives of the entrants to long-term considerations? How do we manage the career progression challenges of existing bureaucrats? How do we mobilise support among employees for this?

Or consider the issue of poor urban management. Several chicken-and-egg conundrums emerge. Where do you start? Directly elected mayors though providing long-term perspective and local ownership, may worsen administrative discipline and increase corruption? Higher FAR may worsen carrying capacity problems, which in turn cannot be tackled over the short-term? Cascaded planning, while useful, may impose restrictions that end up adversely affecting the middle class and those who cannot afford housing in the city centres?

Or easing business environment through deregulation. Flexible labor regulations are likely to be abused by the empowered employers? Given the poor corporate governance standards, wouldn't businesses be tempted to abuse the freedom from reduced inspections and self-reporting compliance? Wouldn't businesses be encouraged to socialise their costs and pollute more?

Such apparently insurmountable and paralysing challenges are inevitable with all fundamental or paradigm redefining policy shifts. There is very little likelihood of policy action on any of these fronts, especially given the deep political polarisation in most democracies. "Breakouts", with all the aforementioned caution, provide a silver lining.

Critics may argue whether demonetisation, with its attendant suffering, concentrated among the poorest, was necessary to achieve the same objective. This is a matter of debate. The challenge, therefore, is to figure out what can be potential "breakout" interventions for these areas.

So what are other possible "breakouts"? In this era of parliamentary logjams, "breakouts" have to be largely executive decisions. Here are a few to mull over. Immediately earmark 25% of central funding in education to be spent on learning outcomes (currently nothing) and not inputs, with it increasing to 75% by 2020. Embrace outcomes-based funding for all central government program allocations, with at least 50% to start with. Mandate far higher FAR, say, in the range of 7-10, in city centres and along the most important transit corridors, as a requirement to receive funding under the Smart Cities project. Target hiring 50 Joint Secretary and above level officials as lateral entrants over the next five years. Radical restructuring of UGC and Medical Council of India to allow greater administrative and academic autonomy for institutions under them.

The "breakout" approach resonates with Albert Hirschman's "theory of the hidden hand". Hirschman said that governments are most often either too risk averse or too intimidated to undertake very large and complex endeavours, given the enormity of the execution challenges and the opposition it would arouse. He therefore argues that in such cases, it helps to have a "hidden hand" which encourages policy makers and politicians to under-estimate the challenges and nudge them into pulling the trigger.

In the context of large infrastructure projects in developing countries in the sixties and seventies Hirschman had this to say,

If the project planners had known in advance all the difficulties and troubles that were lying in store for the project, they probably would never have touched it, because a gloomy view would have been taken of the country's ability to overcome these difficulties by calling into play political, administrative, or technical creativity... We may be dealing here with a general principle of action. Creativity always comes as a surprise to us; therefore we can never count on it and we dare not believe in it until it has happened. In other words, we would not consciously engage upon tasks whose success clearly requires that creativity be forthcoming. Hence, the only way in which we can bring our creative resources fully into play is by misjudging the nature o[ the task, by presenting it to ourselves as more routine, simple, undemanding of genuine creativity than it will turn out to be.

Hirschman's examples were largely about massive infrastructure projects with long construction times, site acquisition and rehabilitation challenges, and massive expenditures. But the "hidden hand" reasoning applies just as well to fundamental process reforms.

Does demonetisation provide the "hidden hand" for the government to venture aggressively into tilting at the informal sector and expanding the tax base? And does it offer guidance for embracing the "breakout" approach to reforms? I am inclined to answer in the affirmative.